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Gold plunges, but are the falls justified?

There is something very contradictory about the fall seen in gold over the last few days.

As of Friday, gold was down 22 per cent from its highs set in the autumn of 2011, when it passed $1,999 a troy ounce. That was the worst bear run since the early 1980s.

Yesterday gold fell 9.2 per cent, suffering its biggest one day fall since the early 1980s. At the time of writing, the pretty yellow metal is trading at $1361 a troy ounce, and is now 29 per cent off its 2011 peak.

The contradictions are many, however.

Markets have often bought gold when QE is increased. Yet in Japan, QE is being launched that will make previous programmes look like a warm–up. The markets are celebrating and in the process selling gold for a complex reason. The economy is not so good, therefore QE will be increased, and therefore the economy will improve, ergo buy gold.

Except the markets did not celebrate at all yesterday, and the Dow lost 265 points. Gold is usually seen as a contrary asset. Buy gold in times of peril. It is unusual for gold and stock markets to fall in tandem.

One explanation is that stock markets fell for transitory reasons, gold for more fundamental reasons.

Yet consider Cyprus. It is selling gold, and that has helped push down the price. But why is it selling gold? Answer: because the government is all but bust. Governments not having any money is usually seen as a reason to buy gold.

In part gold has fallen as other commodities dropped. Brent crude oil, for example, fell to a nine month low this morning.
Capital Economics said: “None of the fundamental explanations being discussed for the slump in gold prices really holds up.”

Unless that is the explanation lies with inflation. Despite all that QE, and despite warnings of hyperinflation, right now global inflationary pressures are very modest. Maybe the penny has dropped. QE, at a time when banks don’t want to lend, is not likely to lead to significant inflation. That may explain falls in gold.

But here is another reason: gold’s allure is purely psychological. It does well because people expect it do well. It does badly because people expect it to do badly.

Impressions matter more than fundamentals. On the BBC this morning, David Buik called gold trading a spiv’s market. It rose a few years ago, because the global banking sector went into meltdown, and some feared a kind of race to the bottom in currency markets, and hyperinflation to be the result. Many of those fears now look hysterical. The mood has changed. Gold does not glisten like it did. And when investors think gold has lost its sparkle, it will fall regardless of what fundamentals say.

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